Section 162 of the Internal Revenue Code lets you deduct all the ordinary and necessary expenses you pay or incur during the year in carrying on a trade or business.1Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses That single sentence controls whether you can write off a cost dollar for dollar, and everything else about IRC 162 trade or business expenses is a gloss on what those words mean. An expense qualifies only if your activity is a real trade or business, the cost is ordinary and necessary in your field, you incur it while operating (not while getting ready to operate or while buying long-lived assets), and it is not personal.
The Threshold: Is Your Activity a Trade or Business?
Congress never defined “trade or business” for purposes of Section 162. The working definition comes from the Supreme Court’s 1987 decision in Commissioner v. Groetzinger, which set a two-part test: you must be involved in the activity with continuity and regularity, and your primary purpose must be income or profit.2Legal Information Institute. Commissioner of Internal Revenue v. Groetzinger
Continuity and regularity rule out one-off transactions. Selling a single inherited property does not make you a real estate business; buying, renovating, and reselling properties throughout the year almost certainly does. The IRS looks at how often you engage in the activity, how much time and effort you invest, whether you keep separate books, and whether you operate the way others in the field do.
The profit-motive prong rules out activities you pursue mainly for enjoyment. You can genuinely like the work and still qualify, but a weekend pottery studio that sells the occasional piece invites scrutiny in a way a full-time consulting practice does not.
Two boundary categories are worth flagging because they look like businesses but are treated differently. A hobby (Section 183) generates taxable income but produces no deductible expenses at all right now: the Tax Cuts and Jobs Act suspended the miscellaneous itemized deduction that hobby expenses fell under, and the One Big Beautiful Bill Act of 2025 made that elimination permanent.3Office of the Law Revision Counsel. 26 USC 183 – Activities Not Engaged in for Profit A passive investment activity (Section 212) is in the same position: the costs of managing a portfolio, safe deposit boxes, and similar expenses currently produce no individual deduction.4Office of the Law Revision Counsel. 26 USC 212 – Expenses for Production of Income Section 162 is where the deductions live, which is why the classification fight matters.
Ordinary, Necessary, and Incurred in Carrying On the Business
Once your activity clears the trade-or-business gate, each expense has to pass the statute’s own language.1Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses
An expense is ordinary if it is common and accepted in your particular industry. It does not have to recur every year. Sales commissions, industry software subscriptions, raw materials, professional dues — all of these clear the bar without argument. An expense is necessary if it is helpful and appropriate for the business. Courts read that generously. You do not need to prove the cost was indispensable, the only option, or the cheapest choice.
“Carrying on” does its own work. It separates day-to-day operating costs from costs that produce a benefit lasting well beyond the current year. Buying equipment, constructing a building, or acquiring a patent creates a capital asset under Section 263, which you recover through depreciation or amortization instead of a single-year deduction.5Office of the Law Revision Counsel. 26 USC 263 – Capital Expenditures
Personal expenses never qualify. Section 262 forbids deductions for personal, living, and family costs.6Office of the Law Revision Counsel. 26 USC 262 – Personal, Living, and Family Expenses Your commute is personal. Your home internet used for streaming is personal. When a cost has both business and personal components — one cell phone, one car — you allocate and deduct only the business portion.
Category Rules That Override the General Test
Several common categories carry their own rules on top of the ordinary-and-necessary standard. These are where audits most often produce adjustments.
Wages and Owner Compensation
Salaries and wages are deductible if the compensation is reasonable for the services actually performed. “Reasonable” is measured against what similar businesses pay for comparable work. Closely held corporations draw the heaviest scrutiny here, because an owner-employee can inflate their own salary to pull profits out as deductible compensation instead of nondeductible dividends. If the IRS finds the pay excessive, it reclassifies the excess as a distribution, which removes the deduction and can create double taxation. Employment contracts, board resolutions, and industry compensation data strengthen your position.
Travel and Mileage
Business travel expenses are deductible when you are away from your tax home long enough that you need to stop for sleep or rest.7Internal Revenue Service. Publication 463 (2025), Travel, Gift, and Car Expenses Deductible costs include airfare, lodging, and local transportation at the destination. Day trips within your metropolitan area are not travel for this purpose, and daily commuting from home to your regular workplace is always personal.
For driving, you can either track actual vehicle expenses (gas, insurance, maintenance, depreciation) or use the IRS standard mileage rate. For 2026, that rate is 72.5 cents per mile for business use.8Internal Revenue Service. IRS Sets 2026 Business Standard Mileage Rate at 72.5 Cents Per Mile The mileage rate is simpler, but taxpayers with expensive vehicles or high maintenance sometimes come out ahead on actual expenses. Either way, you need a contemporaneous log showing date, destination, business purpose, and miles for each trip.
Meals and Entertainment
Business meals are deductible at 50 percent of the cost, including tax and tip, as long as the meal is not lavish or extravagant and you or an employee are present with a current or prospective business contact. The temporary 100 percent deduction for restaurant meals in 2021 and 2022 is gone.
Entertainment is a separate category and is generally nondeductible. Concert tickets, sporting events, and golf outings cannot be written off even when business is discussed during the event.9Office of the Law Revision Counsel. 26 USC 274 – Disallowance of Certain Entertainment Expenses Limited exceptions survive — recreational activities primarily benefiting rank-and-file employees, like company picnics and holiday parties, remain deductible — but the general prohibition catches most entertainment spending.
Home Office
If you use a dedicated portion of your home exclusively and regularly as your principal place of business, you can deduct a share of housing costs like rent, mortgage interest, utilities, and insurance.10Internal Revenue Service. Publication 587 (2025), Business Use of Your Home The exclusive-use requirement trips people up: if your office doubles as a guest bedroom, the deduction fails. Storing inventory and running a daycare in the home are narrow exceptions.
The IRS offers a simplified method that lets you deduct $5 per square foot of dedicated office space, up to 300 square feet, for a top deduction of $1,500.11Internal Revenue Service. Simplified Option for Home Office Deduction The regular method often produces a larger deduction when housing costs are significant. Only self-employed individuals and independent contractors can claim the home office deduction; employees working from home lost this deduction when the miscellaneous itemized deduction was eliminated.
Rent, Advertising, and Insurance
Rent paid for property used in your business is fully deductible, as long as you are not simultaneously building equity in the property. A lease-to-own arrangement has to be capitalized instead of deducted currently. Lease terms between related parties draw extra scrutiny; the rent has to reflect fair market value.
Advertising and marketing costs are fully deductible, including goodwill advertising aimed at building your brand rather than selling a specific product. Insurance premiums for policies protecting business assets — liability, property, business interruption — are likewise deductible. The main exception: premiums on life insurance policies where the business is the beneficiary are not deductible, even if the coverage exists to protect the company from the loss of a key person.
Start-Up Costs Are Not Section 162 Expenses
A common trap catches new business owners who try to deduct all their launch expenses as ordinary operating costs. Money you spend before your business actually opens — market research, training employees, scouting locations, developing supplier relationships — falls under Section 195 as start-up expenditures, not Section 162 operating expenses.12Office of the Law Revision Counsel. 26 USC 195 – Start-Up Expenditures
You can immediately deduct up to $5,000 of start-up costs in the year your business begins operations. That $5,000 ceiling shrinks dollar for dollar once total start-up spending exceeds $50,000, and vanishes entirely at $55,000. Whatever you cannot deduct immediately gets amortized evenly over 180 months starting the month the business opens.
Timing matters more than people expect. If you spend $30,000 preparing a business in 2025 but do not open until 2026, none of that $30,000 belongs on your 2025 return. Keep clear records of when the business transitions from planning to operating.
What Section 162 Status Unlocks — and Costs
Qualifying under Section 162 opens the door to more than just expense deductions. It also lets eligible individuals, trusts, and estates deduct up to 20 percent of their qualified business income under Section 199A.13Office of the Law Revision Counsel. 26 USC 199A – Qualified Business Income The 2025 OBBBA legislation removed the original sunset date and made the deduction permanent. Not every trade or business qualifies at every income level: specified service trades or businesses (law, medicine, accounting, consulting, athletics, financial services) face income-based phase-outs, and services performed as an employee never qualify.
The same classification carries an obligation. If you are self-employed and your net earnings from the business reach $400 or more, you owe self-employment tax covering Social Security and Medicare.14Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes) The deductible half of self-employment tax reduces your adjusted gross income.
Where you report all of this depends on the entity. Sole proprietors put business income and expenses on Schedule C.15Internal Revenue Service. About Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship) Rental and other passive activity income generally goes on Schedule E.
Documentation and Penalties
Claiming Section 162 deductions for an activity the IRS later reclassifies as a hobby or investment creates an underpayment. On top of the additional tax, the IRS typically imposes a 20 percent accuracy-related penalty on the underpaid amount under Section 6662 if the misclassification resulted from negligence or careless disregard of the rules.16Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments Interest runs on both the tax and the penalty from the original due date.
The best protection is documentation, because if the IRS questions your activity or your expenses, the burden of proof falls on you. Keep separate bank accounts and books for the business. Preserve receipts and contemporaneous logs. Hold on to evidence of profit motive: a written business plan, records of changes you made after unprofitable periods, and evidence that you consulted industry professionals. Taxpayers who acted in good faith based on reasonable professional advice can sometimes avoid the accuracy-related penalty even when the underlying deduction is disallowed.